From deferred bonds to issuing in the eye of the storm – what Optivo has learned

Comment02 Oct 2020Tom Paul

Optivo’s Tom Paul reflects on a turbulent six months in the debt capital markets, the importance of market access, and the advantages of retained bonds and deferred settlements

Tom Paul

Tom Paul is Director of Treasury & Commercial at Optivo, and before this was a corporate finance advisor. He’s responsible for ...READ MORE

At the end of March, Optivo was one of the first corporates globally issuing during lockdown (picture: Getty)

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From deferred bonds to issuing in the eye of the storm – what @optivohomes has learned #UKhousing #SocialHousingFinance

Tom Paul @optivohomes reflects on a turbulent six months in the debt capital markets, the importance of market access, and the advantages of retained bonds and deferred settlements #UKhousing #SocialHousingFinance

Much has been written in these pages over the past decade or so on the decline in long-term bank lending, and the rise of other financial institutions in funding the social housing sector.

Even more analysis, perhaps, has been devoted to the trade-offs between ‘public bonds’ and ‘private placements’. Both (broadly speaking) ultimately mean deal-making with the same financial institutions but with different documentation structures.

In this piece I’ll reflect on the value of debt capital markets access, of retained bonds, and of deferred settlement structures.

Market presence drives market access

Back in March, it felt like Optivo was in the eye of the storm in the debt capital markets. We’d announced a public bond transaction before the full implications of the pandemic were reflected by the markets. The penny dropped while we were on our roadshow, and the markets froze. It took nearly a month of ‘go/no go’ calls to pick a day in which we could get a deal done. In the end we were the first corporate issuing sterling public bonds – and one of the first globally – during lockdown.

After much deliberation we had decided it was best for us to secure the long-term funding we needed, which by any historical measure looked attractive on a fixed-cost basis. We didn’t know whether the markets would re-freeze or whether spreads would widen further. In the event, markets unfroze in short order and the spread at which we sold our bonds (230bps, all-in yield 2.857 per cent) now looks high. It was rather like taking an umbrella out on a walk: not doing so guarantees the rain, doing so makes sure of sunshine. Likewise with selling our bonds when we did, funding costs have now reduced!

In our wake, borrowers of all shapes and sizes issued public debt in April/May to shore up liquidity going into the pandemic. Already by September more corporate bonds had been issued than in any prior year. Private markets take their lead from public markets, but were slower to open up after the big freeze in March.

Optivo’s experience last spring has reinforced for me the value of public markets access to seize funding opportunities. We couldn’t have raised the funding we did at that time in the private markets, and neither could we have done so as a debut issuer.

While £250m is a key size for a public bond to be index eligible and attract widest attention, few registered providers are large enough to have this big a funding need all at once, short of major refinancing exercises. Over the past decade or so, providers have used ‘retained bonds’ to gain the critical mass for public markets access.

Retained bonds are created when a bond is first issued, but rather than sold to investors are held by the borrower. They are then sold over time when the funding need arises. There’s no guarantee on the sale, or sale price, but retained bond sales are very straightforward legally. With retained bonds, a provider has rapid market access.

Some larger providers have established public bond ‘programmes’, where legal work for new issues is done annually as a matter of course, making new issues quicker to come to market (subject to security availability). The extra flexibility this offers comes at a cost, and doesn’t quite offer the ‘same-day’ ease of sale as the retained bonds.

The social housing sector has been extremely well served by the retained bonds concept. Back in 2011 when we were first introducing the new wave of own-name social housing public bonds, investors would ask what they are, how voting rights work, will they be sold? Now they’re very much par for the course and in fact are being replicated in the corporate sector.

At Optivo our three public bonds all had a retained element. We sold the first batch in 2013, through a full syndication process to drive the best value from the sale. In 2019 we sold more, this time directly to investors who made attractive unsolicited offers to us. It appears sometimes particular investors have a particular need to put money to work, and by having retained bonds available we could capitalise on their moment of need. We still have more as yet unsold.

Deferred bonds de-risk our future funding needs

Deferred funding structures – where funding is received six months or more after a deal is done – are common in private placements, where bespoke features like this are welcome.

With our latest public markets transaction – a fortnight ago – we pioneered a public sale process for deferred bonds not yet created. We’ll receive £150m (spread 150bps, yield 2.213 per cent, maturity 2043) in 18 months’ time. So we’ve 18 months to make sure we have the bond documentation and property security in place. The market for deferred bond sales is in its infancy and there were relatively few investors able to take part in a competitive process, so after a public announcement of our intention to drive interest we engaged with investors directly. For us, the advantages of this process were as follows:

We de-risk our future funding plans
We paid around 20bps on the spread as a cost of deferral to be spread over the life of the bond. Economically this is lower than the additional interest cost to us of selling bonds today
We push interest costs into the future, protecting our margins in the next two years
We’ll get the funding in time to refinance our £150m Covid Corporate Financing Facility drawings due to be repaid in March 2022
We forward fund development commitments already made
We can now work up the documentation and property security at our leisure knowing the deal is done
As documentation and property security follow the deal, they couldn’t delay it
By tapping our 2043 bond, which has a cash price of around 150%, asset cover is around 70%/76% of the cash we’ll receive

We’ll also take the opportunity of this bond tap process to create more retained bonds for future sale, enhancing our future market access with retained bonds now at different maturities.

Conclusion

Like all developing providers, Optivo expects to have a continuing need for long-term funding. Our experience in recent months highlights the value of access to public debt markets – access we are determined to maintain.

Tom Paul, director of treasury and commercial, Optivo